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Vlad1618 [11]
2 years ago
5

Data for Hugh’s Corporation is provided below. Hugh’s recently acquired some risky assets that caused its beta to increase by 30

%. What is the stock's new expected rate of return according to the CAPM? Initial beta 1.00 Initial expected return (rs) 10.20% Market risk premium, E(Rm – Rrf) 6.00% Percentage increase in beta 30.00% Increase in inflation premium 2.00%
Business
1 answer:
I am Lyosha [343]2 years ago
3 0

Answer:

The stock's new expected rate of return is 14%

Explanation:

Ke=Rf+beta(Mrp-Rf)

Ke is the cost of capital is 10.20%

Rf i the risk free rate which is unknown

beta is 1.00

(Mrp-Rf) is the market risk premium at 6%

10.20%=Rf+1.0(6%)

10.20%=Rf+6.0%

Rf=10.20-6.00%

Rf=4.20%

Beta for the risky asset is 1.00*130%=1.3

New risk rate is the old rate plus inflation rate of 2.00%

new risk free=4.2%+2%=6.2%

The expected return on the new asset is computed thus:

Ke=6.2%+1.3(6%)

Ke=6.2%+7.8%

Ke=14%

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Suppose that an investor with a 10-year investment horizon is considering purchasing a 20-year 8% coupon bond selling for $900.
leonid [27]

Answer:

8.67%

Explanation:

PMT (Semi-annual coupon) = par value*coupon rate/2 = 1,000*8%/2 = 40

N (No of coupons paid) = 10*2 = 20

Rate (Semi-annual reinvestment rate) = 7%/2 = 3.5%

Future value of reinvested coupons = FV(PMT, N, Rate)

Future value of reinvested coupons = FV(40, 20, 3.5%)

Future value of reinvested coupons = $1,131.19

FV = 1,000

PMT (Semi-annual coupons) = 40

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Rate (Semi-annual YTM) = 9%/2 = 4.5%

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Price of the bond after 10 years = PV(1000, 40, 20, 4.5%)

Price of the bond after 10 years = $934.96

Total amount after 10 years = Future value of reinvested coupons + Price of the bond after 10 years

Total amount after 10 years = $1,131.19 + $934.96

Total amount after 10 years = $2,066.15

Amount invested (Price of the bond now) = $900.

Total Annual Return = [(Total amount after 10 years / Amount invested)^(1/holding period)] -1

Total Annual Return = [($2,066.15/$900)^(1/10)] -1

Total Annual Return = [2.295722^0.1] - 1

Total Annual Return = 1.08665561792 - 1

Total Annual Return = 0.08665561792

Total Annual Return = 8.67%

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